Eurozone Default Is Not Synonymous with Breakup

Implicit in my post explaining that Germany is preparing for Greek bankruptcy is the view amongst European policy makers that default does not equal euro zone exit. I think I should reiterate this because a lot of people are acting like an imminent Greece exit from the euro zone is likely. This is not the case. Witness these remarks from the German Chancellor Angela Merkel (CDU) and her Economy Minister Philipp Roesler (FDP):

Mrs Merkel told the RBB radio station: “The top priority is to avoid an uncontrolled insolvency, because that would not just affect Greece, and the danger that it hits everyone – or at least several countries – is very big.

“I have made my position very clear that everything must be done to keep the eurozone together politically. Because we would soon have a domino effect,” said the chancellor.

At the weekend from German Economy Minister Philipp Roesler suggested that Greece would need an “orderly default” on its debts, a comment that sent global share prices tumbling on Monday.

Here’s what they are saying: The German economy is doing reasonably well. But markets are tumbling and business and consumer confidence with it. Our recent election losses are due in large part to this. And indeed, all of this is due to the bailout policy we have taken since the European sovereign debt crisis began. We intend to put a line under that policy.

This extend and pretend strategy at first refused to concede what was plain to all, that Greece could not repay its debts. In July, we decided to move to the soft restructuring approach of maturity extension and interest rate reduction in order to allow our own banks more time to deal with their exposure to Greece.

This plan has not worked. Spain and Italy, large and relatively core members of the single currency, are now in the spotlight. I have made my position very clear that everything must be done to keep the eurozone together politically because we would soon have a domino effect. The increasing interest rates there risks everything and the whole thing could come unstuck. We do not want this because Germany will be blamed for all of this. And as ‘anti-European’ as our government may sound, this is just rhetoric for the masses which are angry that Germany is again being made to take the lion’s share of burden-sharing. The reality is that we in the German government are still very much behind the European project – not at any cost, mind you; but still we are willing to bear our fair share of the burdens to see this through.

In light of Greece’s inability to meet its austerity targets, we now believe that we must move to a hard restructuring of Greek debt, an orderly default that will also involve recapitalisation of banks in Greece, and some in Germany and elsewhere. Finance Minister Schaeuble is already making preparations for this eventuality. The top priority is to avoid an uncontrolled insolvency, because that would not just affect Greece, and the danger that it hits everyone – or at least several countries – is very big.

Euro zone default is not synonymous with breakup.

This post originally appeared at Credit Writedowns and is reproduced here with permission.